When we talk about “estates”, many people might imagine country piles, tracts of land, small fortunes of ‘old money’ passed down through the generations. And in turn, many might assume that estate planning is similarly exclusively for the super-rich – such as the Duke of Westminster who recently died leaving a £9 billion estate.
Perhaps that’s why a lot of people don’t think seriously about estate planning, and in particular, its role in minimising the amount of Inheritance Tax that has to be paid when you die. Yet even if most of us aren’t in the same league as the landed gentry, many people do actually have an estate to plan for.
For the majority of people, your two biggest assets will likely be your pension and your main residence – your house, in other words. The main point to note about these assets is that property is subject to inheritance tax (IHT) while your pension is typically IHT free.
Inheritance Tax, of course, is the main thing that can reduce what you can pass on. The Inheritance Tax Allowance is currently £325,000 in the UK, uncomfortably close to the average price of a detached house, which is £330,574.
Passing on property
In reality though, things are more complicated than ‘average house prices’. There are several property hotspots up and down the country, and in some places, the average price can be well over this figure.
In addition to this, it is possible that a lot of homeowners underestimate the actual value of their property, especially if they’ve lived somewhere for a long time and have had no reason to seek an up-to-date valuation.
This goes some way to explaining why inheritance tax receipts rose from £2.3 billion to £4.6 billion between 2010 and 2016 – a staggering 100% increase, and the result of people falling into what’s known as the ‘inheritance tax trap’, with their beneficiaries losing out on a portion of their potential inheritance.
Reducing your IHT bill
This trend looks set to continue as it’s estimated that these receipts will go up to at least £5.6 billion by 2021. However effective financial planning can make a big difference. Over the last year alone, it’s estimated that individuals in the UK could have saved £595 million through active estate planning.
Looking particularly at the two main assets of property and pensions, there are several things that can be done to reduce your IHT bill.
An additional allowance
For example, if you’re planning on passing your property to your kids in your inheritance, you could receive a higher nil-rate IHT band from 2017. This is because the government has announced plans to bring in an additional allowance of £100,000 from April 2017 which will increase to £175,000 by 2021, to help people pass property down through the generations.
The power of pension freedoms
Regarding your pension, things got a lot more inheritable thanks to pension freedoms, which were introduced in 2015 when the government made some important changes to how pensions can be passed on.
One of the biggest changes was around who can benefit from your pension. It used to be that pension income could only pass to a dependant, so you couldn’t pass it on to your adult children. Instead, they only had the option of a lump sum which in many cases was after a 55% tax charge.
But now anyone can carry on drawing an income from your pension, as long as you nominate them during your lifetime. Your nominee can access the pot at any age, drawing as much or as little as they choose. And they can nominate their own beneficiaries to inherit the pension pot on their death. This allows pension wealth to be cascaded down the generations, with fully flexible access, and without ever forming part of an estate until it is paid out.
Don’t forget about nominations
So inherited drawdown is clearly a very valuable asset in the tax-minimisation tool box. Equally important is that you ‘nominate’ who you’d like the money in your pension to go to (in much the same way that you do when you make your will). Even though the pension provider makes the ultimate decision, your nomination helps to guide them and ensure that the right amount cascades down to the right people in the most tax efficient way. And you can nominate anyone you want.
It’s also important to keep those nominations up to date. So if you have a new arrival into the family – congratulations! And remember to add them as one of your nominations, if you intend them to benefit from your pension when you die. That means they’ll have the best chance of being able to benefit tax-efficiently from any money passed down. Your financial planner can help you organise this.
Lower tax rates on pensions
The other main change from pension freedoms is around the tax due on pension inheritance. If you die before age 75 your beneficiary receives your pension pot which they can access at any time, completely tax free.
If it’s after age 75, your beneficiary will have to pay tax on what they withdraw at their own rates of tax. Careful planning of withdrawals can reduce how much income tax may be payable by spreading it over a number of years rather than accessing it all in one go.
It’s important to understand however, that not all pensions or providers offer these options. Therefore it may be necessary to consider transferring your existing pensions into more modern ones which are fully flexible. This will depend entirely on your personal situation.
Some older pensions for example may not be able to offer all the new pension flexibilities – particularly on death. But they may include valuable guarantees which could be lost on transfer. And transferring pensions whilst in poor health could lead to a possible IHT charge on death so it makes sense not to leave it too late if looking to transfer. Speak to your financial planner to find out if it could be right for you.
There are a few relatively simple things that we can all do to pass on money to dependants in a more tax-efficient way, and the sooner that you start making plans, the better. Estate planning isn’t just for the landed gentry; it really can make a big difference to your financial future, and that of the people you want to inherit.
For more information on estate planning, nominations and efficient tax planning generally, speak to your 1825 financial planner.
The information in this blog or any response to comments should not be regarded as financial advice. Pensions are investments which can go up or down, and may be worth less than you paid in.
Tax laws and rules may change in the future; this article is based on our understanding in October 2016.